Fixed Income Investment Outlook Q4 2023
US: Rates to stay restrictive
Despite the overall restrictive monetary tone for most of the year, economic data for the US has remained surprisingly resilient in 3Q23, which bolstered hopes of a soft landing. After pausing in June, the Fed raised rates by 25bps in July, and the market priced in odds of another hike by the year-end. The Fed’s hawkish tone is expected to prevail as more time is needed to ensure inflation returns to its target and as it considers the cumulative effect of monetary tightening on the economy.
We believe the Fed’s narrative on keeping rates “higher for longer” will stay for the remainder of 2023 – underlying growth appears to remain quite solid, and inflation is still some way far from the target. Although high energy prices are already on the Fed’s radar, we are mindful of any Israel-Hamas war-induced upward trend, which may add incremental pressure on headline inflation.
The strong and durable labour demand continues to provide some buffer to household income and private consumption. Nevertheless, with restrictive rates taking a toll on the economy, we continue to expect job and inflation data to soften and show signs of weakness. Some downward pressure on growth may arise, given the potential weakening in payrolls, consumption, and investment sentiment. Overall, moderating growth in the US is a more likely scenario heading into 2024, and we believe the path of a rate cut is still far-fetched.
China: Need more policies to jumpstart the economy
After China’s GDP rebounded to 6.3% in 2Q23 YoY due to a low base effect, its economic momentum bottomed out and moderated to 4.9% in 3Q23 YoY due to sluggish property sales and both retail sales and infrastructure investment decelerating on a high base. China has accelerated easing efforts since August, including demand-side measures for the property sector and RRR cuts, as well as speeding up the issuance of special local government bonds. On the property front, we believe these policies help set a nationwide and symbolic guidance in reviving sentiment in high-tier cities. Nevertheless, we believe the sector will take time to heal, and a sustainable sales recovery requires an improvement in expectations of income growth and job security.
The slower growth trajectory shall keep the ongoing path of accommodative measures into 2024, including the expansion of the fiscal budget, which requires more debt issuance to fund infrastructure projects and continued easy monetary policy. Other than boosting growth, these measures may address falling land sales and the tight funding environment for LG/LGFVs, which have warranted attention from the government. The Central Economic Work Conference in December shall give us some clues on the magnitude of fiscal expansion set for next year.
We believe a policy stimulus tilted toward private consumption would be more desirable and effective in rebalancing the growth outlook. On the other hand, interest rate cuts and credit expansion appear to be not as effective, given the overall subdued household and business sentiment. We believe a massive rate cut is unlikely due to the unwanted impacts on capital outflows, currency depreciation, and banks’ financial health. Hence, we see challenges remain for the government in addressing the efficacy of fiscal expansion, demographic issues, and ways to achieve more sustainable and high-quality growth in the medium term.
Asia: Manageable inflation challenges
After the pandemic, Asia’s growth recovery remains in an improving path, thanks to the region’s resilient domestic demand. Although the slowing global and Chinese demand weighed on Asian exports, the impacts should have largely bottomed out. Moreover, inflation challenges have not been as fierce as in the West and are mostly in line with Asian central banks’ expectations, such that they were able to pause rate hikes during the ongoing US hike path. As a result, Asian onshore bond yields have not risen as much compared to the US. Overall, we believe there is a high bar for Asian central banks to resume rate hikes, especially when the inflation outlook is benign. That said, the higher for longer US rates outlook will delay Asia’s rate cut cycle. Geopolitical tensions and the resulting surge in oil prices warrant caution, as a sustained overshoot may pose inflationary pressure and the resumption of rate hikes, given that most Asian markets are importing nations. Currency weakness could pose risks to Asia USD bond issuers, but peaking US rates and foreign exchange interventions that stabilize domestic currencies should see manageable impact on the asset class.
The fundamental outlook of Asia and China investment grade (IG) bond issuers remains solid with low default rate risk, supporting credit spreads. The landscape of Asia high yield (HY) has changed significantly, with fewer constituents from the Chinese property sectors, reflecting an increasingly more stable credit quality in our view. Credit selection and identifying dislocation opportunities remain crucial; the pace and breadth of corporates’ earnings and cash flow recovery remain our key focus. Bond buybacks have also become more prevalent, which reduce the refinancing burden for bond issuers and underpin technicals for the select HY segment. Given the stabilizing credit outlook, improved sector diversification, and expectations of lower default rates, we see a better value proposition in Asian HY bonds heading into 2024 (Figure 1). Decent carry also provides downside protection in an overall slowing growth environment.
We prefer a barbell strategy to balance risk reward in a likely challenging 2024 with restrictive US rates and China’s patchy growth recovery. On the one hand, Asia IG bonds, yielding 5-6%, provide a decent income choice with a shorter duration than its US peers. We see some opportunities to rotate into longer-term bonds to reduce the re-investment risk when there is a clearer picture of the path for a Fed pivot. The Asian HY space also offers pockets of opportunities for issuers with decent-quality assets and access to onshore capital markets that facilitate their ability to refinance. Our themes on credit selection stay with those beneficiaries from a consumption-led recovery or deleveraging trend. We monitor the speed of a fundamental turnaround in China and maintain our strategy of diversifying our exposure into India, Indonesia, Hong Kong, and Macau.
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The views expressed are the views of Value Partners Hong Kong Limited only and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All materials have been obtained from sources believed to be reliable as of the date of presentation, but their accuracy is not guaranteed. This material contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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